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Developers reaching beyond traditional sources of financing

With capital flowing freely for the moment, most developments these days are being conventionally financed. But that isn't always the case; in an economic downturn, the unconventional could become the rule rather than the exception.

The Corky McMillin Cos. still obtains most of its funding for residential and commercial project from banks. However, McMillin Capital, a real estate investment and management unit of Corky McMillin Cos., earlier this spring announced that it had closed its third real estate private equity fund, totaling $47.6 million for San Diego-area projects.

The $47.6 million, obtained from investors in the United States and Asia (the Corky McMillin Cos. has an office in Seoul, South Korea), was used to fund land development, entitlement and residential for McMillin projects in California, including Ventanas and Cielo Azul in the El Centro's Sky Ranch; Meadow Peak in Santa Clarita; Blackstone in Temecula's Morgan Hill master plan; Capella in Bakersfield; and the Del Lago master plan in Tulare. About half of these funds were obtained from Asia.

The first fund, which initially totaled $6 million, invested in two office buildings at Liberty Station at the old Naval Training Center, a McMillin project.

A majority of these investors chose to increase their capital commitments to build and hold five additional office buildings at Liberty Station and transform the venture into an investment fund. Thus far, this venture has funded $23 million of the $33 million required for these buildings.

The second fund, which totaled $6.8 million, invested in McMillin Morgan Hill, a master-planned community in Temecula.

Wade Hall, McMillin Capital president and CEO, said his firm is on target to garner more than $200 million for investment within the next two to three years. Hall added that while most of this money will go to McMillin projects, the intent is to bankroll developments that are outside the company.

McMillin Capital typically gets about 20 percent of its funds from Asian sources, and while Asia is large, Hall said, "The banking community is really small."

Hall noted that the largest builders either get their money from Wall Street, or like Lennar (NYSE: LNR), have their own huge capital arm. McMillin's right now is on a much more modest scale, but is expected to grow significantly in time.

"But we are not setting ourselves up to be giants in the capital markets," said Donald Renfro, McMillin Capital executive vice president.

McMillin Capital may not become huge in the capital markets, but in an economic downturn, having diverse capital sources could make the difference as to whether a project gets financed.

Where a developer gets its capital can also easily change over time. Constellation Property Group, a Sydney, Australia-based developer with its North American offices in San Diego, had relied heavily on Australian funds to bankroll its projects here when it first arrived a couple of years ago. Today, while Australian capital still plays a role, it will decrease over time.

"We're moving away from Australian capital sources because of the exchange rate," said Stephen Scotchmer, Constellation chief operating officer.

An example of this shift is the approximately 250-unit Revolution project Constellation is developing in National City. United Commercial Bank of Los Angeles is the lender on that project.

"They have become a very important debt partner for us," Scotchmer said.

Nat Bosa, the Vancouver developer who built much of the downtown residential skyline, warned that it will become more difficult for condominium develops to obtain financing.

"It's going to become a lot tougher," Bosa said. "Banks are doing their job. They learned a lot from the crash of the 1980s. Unless you've got a good track record and a good location, some developers aren't going to get to go ahead."

For the moment, Bosa said there is plenty of capital, but just because it's there doesn't mean developers should rush forth to do their projects.

"We developers are like pigs at a trough. Lenders throw money in the trough, we eat it, and then we get slaughtered," Bosa said.

Bosa, who gets his money from a wide range of conventional sources from Bank of America (NYSE: BAC) to the Royal Bank of Canada, said though undisciplined developers may get hurt, if the fundamentals make sense, projects can still work even in a downturn -- especially in a highly desirable city.

"San Diego is not going anywhere," Bosa said.

Sherm Harmer, president of Urban Housing Partners and chairman of the Downtown Residential Builders Alliance, said the sources of financing haven't changed, but lenders are demanding more equity up front.

"Six months ago they were providing 80 percent loan to cost. Today, it is a 70 to 75 percent loan," Harmer said.

Combine that with rising construction and land costs, Harmer said, and a project can quickly be rendered unviable.

"There are about half a dozen projects that are stalled because of economic feasibility issues," he added.

Not everyone agreed that capital is becoming harder to acquire. Tony Dolim of Newland Communities, developer of 4S Ranch among other projects, said, "Lots of capital is still available."

Richard Gustafson, president of Citymark Development of San Diego agreed. "If you have a good project and a good location, there is still money out there," Gustafson noted.

CityMark has been using Comerica Bank and Bank of America for its construction lending.

Fred Maas, president of Black Mountain Ranch LLC said if he had to do the big master plan today, he doesn't know if he could pull it off.

"There has been a considerable sea change. It's difficult to do large land projects. There is such a long lead time," Maas said.

Maas added that Black Mountain Ranch was fortunate to forge a financial partnership with St. Paul Travelers Insurance and Institutional Housing Partners.

While some are saying lending is about to fall off for residential projects, Randall Borchardt, vice president of commercial lending for San Diego National Bank, suggested the commercial market may be stronger.

"While there are some very early signs there may be some changes ... a recent Federal Reserve survey doesn't anticipate any change in the commercial markets," Borchardt said.

Borchardt said commercial banks continue to lead the way in the lending arena, followed by insurance companies and hedge funds. The California Public Employees' Retirement System has also been a very prominent lender here.

At least one type of lending that appears to have gotten easier involves new hotels. Hotel consultant and developer Robert Rauch said as recently as 2003, lenders were charging as much as 400 basis points above the prime rate. The reason it was so high, he said, was because of Sept. 11 and its aftermath. The spread has since lessened to about 150 basis points today.


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